At an open meeting held on July 1, 2015, the Securities and Exchange Commission (SEC) issued a concept release seeking input on whether it should adopt rules requiring additional disclosures for audit committees, with a focus on the audit committee’s reporting of its responsibilities and activities with respect to its oversight of the independent auditor.¹ The concept release states that the SEC “is seeking feedback to better understand whether additional audit committee reporting requirements related to the oversight of the auditor would provide useful information to investors and if so, what information would be useful.”

Companies and members of audit committees should consider providing comments to the SEC on the concept release and the questions posed by the SEC therein on the types of disclosures that should be required in order to provide the SEC with insight prior to any proposed rules being issued.

Background

Audit committees have primary responsibility for overseeing the integrity of a company’s accounting and financial reporting processes. One of the most significant ways that the audit committee performs this role is through the appointment, compensation, retention, and oversight of the company’s independent auditor, which reports solely to the audit committee. To ensure audit committees perform this function effectively, the SEC adopted rules in 1999 requiring disclosures related to the functioning, governance and independence of audit committees, which are primarily set forth in Item 407 of Regulation S-K. Following a wave of corporate fraud in the early 2000s, the Sarbanes-Oxley Act of 2002 mandated a number of reforms to enhance corporate responsibility, including by expanding the role of the audit committee in the financial reporting process, enhance financial disclosures and eliminate fraud. Sarbanes-Oxley also established a new regulatory and oversight regime for auditors of public companies, including the creation of the Public Company Accounting Oversight Board (PCOAB).

Despite the enactment of the Sarbanes-Oxley Act, the SEC’s rules relating to audit committee disclosures have not changed materially since their adoption in 1999. More recently, certain investors, organizations and auditors have expressed views that improvements can be made to audit committee disclosures. In its concept release, the SEC states that “[w]hile current audit committee requirements provide information about the role of the audit committee with respect to its oversight of the auditor, these disclosures do not describe how the audit committee executes its responsibilities.” The SEC also speculates that additional required disclosures may enable investors to “differentiate between companies based on the quality of audit committee oversight.”

As a result, in its concept release, the SEC has opened the door to a host of potential changes to the audit committee disclosure rules, and is requesting public comment on these possibilities.

Concept Release

Overall, the concept release seeks input in order to assist the SEC in (i) understanding whether changes should be made to required disclosures about audit committees regarding oversight of the audit and the company’s relationship with its auditors and (ii) whether additional disclosure would help inform investment and voting decisions. Specifically, the concept release sets forth three main topics, each summarized below, for disclosure and requests comments on specific questions related to such topics.

1. Audit Committee’s Oversight of the Auditor. The SEC seeks public comment on whether it should require an audit committee to disclose additional information about the audit committee’s consideration of the specific matters discussed with its auditor pursuant to Auditing Standard No. 16, including addressing the nature of the audit committee’s communications with the auditor related to strategy, timing, significant risks identified, nature and extent of specialized skill required for the audit, planned use of other independent auditors and results of the audit. The release then proceeds to ask a number of questions on potential disclosures relating to the following topics: (a) specific communications between the audit committee and the auditor, (b) the timing, frequency and forum for meetings between the audit committee and the the auditor, (c) the audit committee’s review and discussion of the auditor’s internal quality-control review and most recent inspection report from the PCAOB, and (d) whether and how the audit committee assesses, promotes and reinforces the auditor’s objectivity and professional skepticism, with the SEC specifically noting that “[h]eightened oversight by the audit committee of the auditor’s objectivity and professional skepticism should promote greater audit quality.”

2. Audit Committee’s Process for Appointing or Retaining the Auditor. The SEC also invited public comment on whether it should issue rules requiring disclosure of additional information about the processes the audit committee uses to reach a decision about which auditor to select for an upcoming year. The release then proceeds to ask a number of questions on potential disclosures relating to the following topics: (a) how the audit committee conducts an assessment of the auditor—including the auditor’s independence, objectivity and audit quality—and the audit committee’s rationale for selecting or retaining the auditor, (b) whether and how the audit committee sought proposals for the independent audit and the factors the audit committee considered in selecting the auditor for a particular audit period and (c) disclosure related to the board of directors’ policy, if any, for annual shareholder votes on the selection of the auditor as well as the audit committee’s consideration of the voting results when selecting the audit firm, including situations where the audit firm does not receive the required vote.

3. Qualifications of the Auditor and Certain Members of the Engagement Team Selected by the Audit Committee. Finally, the SEC asked for input on whether it should require additional disclosures with respect to the key participants in an audit, their experience and their qualifications to perform a high-quality audit, including, but not necessarily limited to, the engagement partner and engagement quality reviewer. The release then proceeds to ask a number of questions on potential disclosures relating to the following topics: (a) information about certain individuals on the engagement team, such as the engagement partner or other members of the team, (b) the factors the audit committee considered in providing input on its auditor’s assignment of the engagement partner, (c) the number of years the auditor has audited the company, and (d) other firms involved in the audit.²

Commenters may also express their views on other audit committee disclosures beyond the three areas of focus. The release also seeks feedback on whether required audit committee disclosures should be different for smaller reporting companies and emerging growth companies.

Take-Aways

In light of the concept release, it seems likely that the disclosure rules for audit committees will be expanded in the future. Whether these additional disclosure requirements can achieve an appropriate balance between providing investors with additional valuable information, on one hand, and requiring burdensome and lengthy boilerplate disclosures is yet to be seen.

Companies and audit committee members should consider reviewing the questions in the concept release and providing the SEC with comments in order to help shape the any forthcoming proposal around a balanced set of rules that will be valuable to investors without imposing unnecessary burdens on companies. Comments are due 60 days after the release is published in the Federal Register, which due date is expected to be in early September 2015.³

¹ The concept release is available here.

² The PCAOB is also exploring a requirement that the auditor disclose, in its audit report, the name of the engagement partner as well as the names, locations and extent of participation of other independent public accounting firms that took part in the audit.

³ For instructions on how to submit a comment to the SEC, refer to the bottom of the first page of the concept release.